How Banks Work (vs. How People Think They Work)

It is utterly amazing how many people still believe that when they deposit their cash at a bank, the money is dutifully socked away in the institution’s vault, where the bank pays a small amount of interest for the privilege of storing that cash until the depositor returns to retrieve it, without any stipulations or conditions whatsoever.

A smaller percentage of the population “understands” that the bank is allowed to take a small portion of the depositor’s cash and loan it to low-risk borrowers at a reasonable rate of interest.

Of course, that’s not how it works.

In fact, most people would be shocked to know that when they deposit their cash in a bank, they become an unsecured creditor. Yes, the money is federally insured — but most people are unaware that in the US, the Federal Deposit Insurance Corporation, has less than $25 billion on hand to cover more than $9 trillion of eligible deposits.

In short, our banking system is the biggest con game in the world. With that in mind, here is a slightly revised version of a meme I recently saw floating around the web that succinctly describes just how fraudulent banking has become.

How People Think Their Bank Works

Jack deposits $1000 at the bank

The banks loan $1000 to a borrower, Jill

Jill pays the loan back, plus 10%

Result: The bank makes a 10% profit ($100)

How Banks Worked Until the Great Financial Crisis in 2008

Jack deposits $1000 at the bank

The banks loan $10,000 to a borrower, Jill

Jill pays the loan back, plus 10%

Result: The bank makes a 10% profit ($1000; i.e., 100% of the original deposit)

How Banks Have Worked Since 2008

Jack doesn’t have to deposit anything (savers are an inconvenience)

The Fed conjures up fiat money on a computer screen and gives it to the bank

The bank loans $250,000 to a sub-prime borrower at 4% interest so they can buy a house worth $100,000

Result: Out of nothing, the bank makes a 4% profit annually for 30 years ($10,000 x 30 = $300,000).

And if you don’t believe me, try going to the bank and informing the banker behind the counter that you’d like to immediately withdraw more than a few thousand dollars of your money from your account. The odds are, she’s going to tell you that it will take at least a day or two to honor your request.

But, hey … at least you’re earning 1% interest or so for all of that trouble.

Comments

A very important point you sort skipped over there that most people don’t understand about out debt money system Len…..

That $9,000 difference between what Jack deposited and Jill borrowed DID NOT EXIST until Jill got her loan. To make Jill that loan, the banks have the power to conjure money out of thin air !

Try explaining that to folks that have no knowledge of it, and they look at you like you are crazy…..as it actually IS crazy to give banks the power to create what passes for money.

But once you grasp the understanding that ALL our ‘money’ is based on debt, either of the govt or plain ole folks….you start to grasp why we have a problem.

Take inflation, for example….it is a built in factor to a debt based money system. Since the money supply MUST constantly expand….to pay back the loan PLUS interest….more money has to be ‘created’ to take care of both. Built in inflation, guaranteed….meaning your ‘money’ CAN NOT retain value long term, and thus fails to actually meet one of the primary definitions OF money.

It also explains why the govt spends $200 on a common hammer, or $800 on a toilet seat, or funds 2 million bucks for a study of the sex habits of newts. Once the consumer reaches their maximum amount of borrowing ability (being constrained by stupid things like income), the govt steps in to keep up the rate of borrowing. And you get the national debt we have….and IT WILL NEVER EVER decrease, despite the blather of politicians.

Great comments, as usual, Andy. You’re right, I assumed people would understand that extra $9000 was created out of nothing, but I’m glad you pointed it out!

Unlike our current debt-based system, a monetary system backed by precious metals can exist in the presence of deflation without imploding. Of course, savers and consumers would both benefit via the increased purchasing power of the money. In fact, from just after the US Civil War until the end of the 19th Century — a time of great economic growth — the US economy was in a state of almost continuous state of mild deflation.

Andy, I agree with your observation, except for debt never decreasing. All fiat (“promise to pay” instruments unbacked by a hard asset, e.g. gold) money systems eventually lose trust because of hubristic excess. Hopefully, it will be slow and controlled, as Len and others have written elsewhere.

My concern is what happens to the hard assets (and the very lives) of debt-free people if the “lose out” is an uncontrolled collapse?

It is a nuanced argument. For the current debt-based monetary system to continue limping along, the debt MUST continue to increase, or the system will quickly seize up.

That being said, I agree that when confidence is finally lost and the dollar hyperinflates, there will be enough dollars printed to pay off existing debt … but the currency will also be absolutely worthless at that point, and the system will have imploded — finally exposed for the con game that it has always been. (To put it another way, when the dollar becomes worthless the debt owed in dollars also becomes worthless.)

Sadly, in a hyperinflation event, the savers and lenders get screwed. It is the debtors who make out like bandits. If there is an uncontrolled collapse, I expect supply chains to break and stay broken until a new system is put in place; my guess is three to six months — but I’m a pessimist, so who knows? A new system could be established much quicker than that.

Those with hard assets who can make it through this period without eating all of their hard asset “seed corn” will be just fine.

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